Sovereign Debt Restructurings: Some Comments Benu Schneider

1. Sovereign Debt Restructurings:Some Comments Benu Schneider The views expressed are those of the discussant and do not necessarily represent those of the Financing for Development Office, Department of Economic and Social Affairs, UN

2. Some messages from today’s presentations • Discontent with present mechanisms for both private and official debt amongst all stake-holders • Both pre-war and post-war interest arrears accumulate sometimes exceeding the defaulted (and sometimes original) amount • Role of official sector, credit rating agencies, creditors criteria questioned

3. Some questions on Belize restructuring • Do market swaps in Belize provide breathing space or a permanent solution to the debt problem? • What is the estimated recovery value? • Why did lenders continue to pour money- What is needed in financial architecture to ensure responsible lending? • What according to his view are distress signals? (if low inflation, interest rates, tourism revenue are not and why did the market not respond to them? • When should a country default – before or after capital flight?

4. Signaling mechanism • International Monetary Fund • Paris Club Agreements on official bilateral debt restructuring • The World Bank • Credit Rating Agencies

5. IMF Forecasts Overoptimistic • The dominant bottom-up (surveillance has a strong country orientation) approach yield consistently overoptimistic forecasts for certain regions • Does not sufficiently pick policy spillovers in a global context IEO, IMF, September 2006

6. WEO forecasts • U.S. General Accounting office (2003) found that between 1990 and 2001, WEO forecasts for growth and inflation were optimistically biased for 57 countries under IMF supported programs • Others such as Ghosh and others (2005) cite evidence that optimistic bias is no greater in program countries than in nonprogram countries

8. Do transparency and information lead to be better assessments? IMF has been the main driving force for transparency and yet the data in its publications is outdated by several months and sometimes years even if the country is fully compliant with data standards

9. The role of the IMF in Paris Club negotiations • IMF involvement in mediating debt-rescheduling agreements between debtor countries and official creditors through its role in the Paris Club does not necessarily reflect debt distress. • The financing of Fund Programs has become dependent on debt relief • This has coincided with the build-up of arrears •  Bi-lateral flows have increasingly been used to pay International Financial Institutions • The amount of debt relief is contingent upon a Fund Program and its estimate of financing gap and in recent times debt sustainability analysis. • Problems with both these sets of estimates by the IMF (Continued…)

10. The role of the IMF in Paris Club negotiations • Role of the IMF as gatekeeper not compatible with supplier of concessional resources and - issue of moral hazard at the BWIs. • This conflict of interest entails that countries do not receive resources because of good policies and governance, but because they have a high debt burden. The problem of adverse selection. Bad policies receive more resources. • Except for HIPC and MDRI, multilaterals as a creditor class are excluded from debt negotiations because of their preferred creditor status • Debt relief was often provided through re-scheduling which postponed, but did not reduce debt payments but led to a bunching of payments in the future. This combined with the problem of overoptimistic forecasts and underestimated financing gaps.

12. Gap in financial architecture? • The Paris Club is an ad hoc machinery which emerged as a result of international cooperation and not an international agreement on financial architecture • Functions like a debt collecting agency • Negotiations are influenced by the foreign policy objectives of the creditor countries

13. Serial rescheduling • Short consolidation periods to keep debtors on a short leash • Mistakes in projections by the IMF • «Snowballing» debt because of bunching of repayments due to lower grace periods; market interest on non-ODA on new reschedulings; and new credits issued after rescheduling

14. Serial Rescheduling: A Gap in International Financial Architecture ? Increase in debt and debt servicing Liquidity /Solvency Problems Agreement with the Fund - a new loan Agreement with the Paris Club Agreement allows new credits from Paris Club Creditors Houston Terms Repayment and Grace Periods: 2-8 years non-ODA, 10 years ODA Repayment Period: 5-10 years Increase in debt and debt servicing - Further increase in debt servicing because non-ODA is negotiated at market interest rates - Bunching of repayments Estimates of financing gap are based on forecasts of growth and other variables that are over optimistic This cycle continues leading to higher levels of debt-stock and debt-servicing In the near future repayment problems surface again A new arrangement with the Fund

15. The changing role of Paris Club • Rescheduling in the Paris Club was originally perceived to lead to an avoidance of default • Debt relief was supposed to be treated as an unusual event • It was not to be directly associated with development assistance • It was meant to be short term without considerations of long term debt relief

16. The Paris Club today is dealing with three sets of problems Liquidity problems Solvency problems Debt relief for development expenditure The treatment accorded may sometimes be the same for all three sets of problems The changing role of the Paris Club

17. Some issues in debt rescheduling at the Paris Club • International financial structure for official debt has flaws, leading to serial rescheduling and unsustainable debt • Originally, the rescheduling at the Paris Club perceived to deal with relief to avoid a default, an exigent and short-term remedy, to be treated on merits alone without consideration of any long-term relief. It was treated as an unusual event. It was not directly associated with development expenditure • Presently the Paris Club reschedules debt for countries with liquidity and solvency problems as well as provision of debt relief to finance development expenditure • In practice solvency problems are very frequently dealt with like liquidity problems (except for HIPC countries and politically motivated restructurings.) Deferring payments into the future finances development expenditure for non-HIPC countries.

18. It is suggested that: • Liquidity problems should be dealt with by the IMF -medium- and long-term problems for debt flow and stock reductions at the Paris Club or another suitable body • Paris Club mechanisms for financing expenditure under the PRGF needs to be further researched and a comparative cost-benefit analysis with other sources of finance such as donor commitments, drawing down on their quota at the IMF, established relationships with banks and other investors. • More transparent machinery is needed for both official and private debt restructuring. Challenge to bring debtors and creditors together, independent information and political buy-ins.